By How the U.S. Dollar Became Dominant in International Trade
You may have heard the U.S. dollar described as “the global reserve currency.” But why is the majority of international trade conducted in dollars? Recently, a growing discussion has emerged, particularly among nations in Asia and Africa, about lessening reliance on the dollar for global trade.
Today, we look into how the dollar became the primary currency for global transactions.
The dollar’s extensive use began in the mid-1940s, after World War II. In July 1944, representatives from 44 countries convened in Bretton Woods, a village in New Hampshire in the north-eastern United States. The purpose of the meeting was to devise a plan for funding the rebuilding of their economies after the devastation caused by the war.
South Africa, Liberia, Egypt, and Ethiopia were among the African countries that participated in the talks, along with the U.S., China, the UK, France, and Belgium. After three weeks of deliberation, the delegates reached an agreement to establish two pivotal institutions: the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD). These organizations were set up to provide financial assistance to member nations.
The IMF was intended to provide short-term loans to countries facing financial crises, while the IBRD focused on funding the recovery of war-impacted nations and supporting less developed countries.
A critical outcome of the Bretton Woods Agreement was the empowerment of the IMF to maintain a system of fixed exchange rates, anchored by the U.S. dollar and gold. Member nations were required to tie the value of their currency to the dollar, while the IMF accepted gold as a means of loan repayment. The IMF also sold gold to countries in need, and the U.S. dollar was used for these transactions, with gold priced at $35 per ounce. Many countries preferred storing wealth in gold because its value did not diminish over time.
In 1971, U.S. President Richard Nixon halted the conversion of dollars into gold. By then, more than 120 countries had joined the IMF, and by 1973, most nations were trading their currencies with the U.S. dollar, which was considered relatively stable. Over time, the dollar became increasingly prominent, becoming the preferred currency for global commerce.
Due to its widespread adoption, the dollar became the world’s reserve currency. A reserve currency is a foreign currency held in large amounts by central banks. Nations maintain reserves for various reasons, including to cushion against economic shocks, pay for imports, settle debts, and manage the value of their domestic currencies.
Today, the dollar accounts for 58% of global foreign reserves and more than 50% of international trade, according to The Atlantic. However, in recent years, countries like Ethiopia, Seychelles, China, and the United Arab Emirates have entered into separate currency swap agreements to reduce their dependence on the dollar.
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